It is troubling times for poultry growers and producers in the state as they grapple with higher costs for feed coupled with soaring energy costs and turbulence in Russia that could impact exports.
“Things are, indeed, challenging in the poultry industry,” said Mike Cockrell, CFO and treasurer, Sanderson Farms Inc., Laurel. “The very high cost of feed ingredients has cut into the margins of every poultry and other protein producer. While this cycle and downturn are unique in some ways, the fact we are having a down cycle is not unique. Cycles in our industry are part of the territory.”
Pilgrim’s Pride recently closed plants in Arkansas and Louisiana, stating that cutting back production is necessary to decrease the supply in order to prop up prices. Approximately 600 jobs were lost. Many other companies have also announced production cuts.
For the past six weeks, the number of eggs placed in hatcheries (which is a good leading indicator of how much meat will come to market 10 weeks later when those eggs have hatched and grown to marketable weights) has averaged almost 5% below the same period a year ago.
“That means that the industry as a whole is planning on producing 5% less meat this fall than last year,” Cockrell said. “It is also the predictable reaction of the industry during a down cycle. When a company’s margins have eroded or disappeared as they have this year, companies produce less meat in order to reduce their losses and protect their balance sheets. Less meat also tightens the market, hopefully increasing the price for chicken and improving the bottom line.”
Cockrell said everyone in the protein industry, whether chicken producers, cow calf operators or hog producers, are worried about the cost of fuel and grain. Corn closed above $8 a bushel this summer, and it was $2.25 a bushel three years ago. During fiscal 2007 alone, Sanderson Farms feed grain costs were $126.7 million more than during fiscal 2006.
“We processed more than two billion pounds of chicken during 2007, and the cost of producing a pound of chicken increased over 6¢ per pound,” Cockrell said. “Given where prices are now and where they have been during 2008, we now estimate that feed grain costs alone will cost us over $173 million more this year than last year. That is $300 million more in costs from feed grain alone over the past two years, and prices are expected to be even higher next year.”
While this is not the first time the industry has faced high grain costs, the reason for the higher costs is different. Five years ago, the ethanol industry was using less than 5% of the corn produced in the U.S. Cockrell said this year that industry will use almost a third of the corn produced, and that percentage is expected to go even higher.
“What this means is that going forward, unless there are changes made to the country’s ethanol policies, 40% or more of the corn produced in this country will go to fuel, not food,” he said. “This is not necessarily a bad thing, and developing a long-term solution to the fuel crisis in this country is above my pay grade, but I do know that there are serious issues policy makers need to consider and debate. The current tax credits and subsidies given to ethanol producers and tariffs that restrict ethanol produced in other countries using other commodities at less cost have hindered the protein industries’ ability to compete for corn on a level playing field. Ethanol producers can afford to pay more for corn than we can because of the tax breaks and other incentives they are getting.”
Despite the challenging times, Sanderson Farms as a company and poultry as an industry actually returned decent margins in 2007. At the same time, grain increased costs more than 6¢ per pound, the overall chicken market increased 12¢ per pound.
But the current outlook is not as bright with production costs expected to increase between 7¢ and 8¢ per pound because of even higher costs, while chicken markets actually declined three cents per pound during the third quarter.
“That combination does not work,” Cockrell said. “The decline in market prices has resulted primarily because of weakness in the casual dining market. Casual dining companies (such as Chili’s, Olive Gardens, Applebee’s and others) have been reporting significantly reduced traffic through stores because of high gasoline prices and general worries about the economy. People simply are not eating out as much in this economy. We are talking anywhere between 7% and 9% fewer people eating out this year compared to last year. That is a big number, and has significantly reduced demand for boneless breast meat and wings, which are the primary products sold through those channels.”
Until the general strength in the economy returns, Cockrell expects that trend to continue. But the company has confidence that, as always in the past, the rules of economics and supply and demand will work to move chicken market prices high enough to allow the company to offset the higher costs.
It starts when companies began reducing supply and taking capacity out of production as is being seen now, which eventually will constrict supply resulting in higher prices. If the higher prices are not enough, the industry will cut more.
“What this means, though, is that the consumer will be paying more for chicken and other proteins at some point in the near future,” Cockrell said. “Lucky for us, our protein is not only the most economical, it is also the best tasting, the most versatile and the healthiest. So even at higher costs, we believe consumers will flock to our product.”
Sanderson Farms has two levers used to improve profitability and increase shareholder value. Those are the efficiency with which it operates its plants and the number of pounds it sells into the market. Because it cannot control either the cost of grain or the cost of chicken, the company focuses on looking for ways to become more efficient and evaluating ways to continue the rapid growth the company has experienced over the past 15 years.
“The key to remaining profitable in this environment is to continue to focus on what we can control,” Cockrell said. “As I said, we have confidence the rules of economics will return the industry to profitability. We want to be the most efficient operator so we return to profitability first. We have always had one of the strongest, most conservative balance sheets in the industry, which gives us great confidence we will weather the cycle and emerge strong on the other side when market conditions improve.”
Growth in the export market has accounted for much of the growth the industry has experienced since 1997. The export markets have grown at a double digit pace. Cockrell said that is a doubled edged sword: that has been really good for the industry and Sanderson Farms, but it also exposes the industry to external factors such as politics and world economic woes.
“Russia recently announced that it will not take product from 19 plants that were previously approved for export to Russia,” Cockrell said. “Russia accounts for a full 34% of our industry’s exports, and is by far the industry’s most valuable trading partner outside the U.S. Banning product from 19 plants is not really a big deal. Companies like ours will shuffle production to other approved plants and make that work. It is another matter altogether, though, if, like during 2002, Russia places a total ban on United States chicken for whatever reason. During 2002 it was politics. There has been some strong rhetoric between the two countries lately, and we will watch it carefully.”
The last severe down cycle in the industry was prompted by Russia’s ban on U.S. poultry in 2002 in response to President Bush’s tariff placed on Russian produced steel. That ban resulted in a glut of chicken into the domestic market and prices moved very low.
Contact MBJ contributing writer Becky Gillette at firstname.lastname@example.org.